Armor

From Basin Wiki

Armor reduces physical damage done against you by a certain percent. It depends on the level of the monster (or player) hitting you. Your own level doesn't matter. By hovering your mouse over Armor on your Character screen, you can see the value of this reduction for monsters that are at your current level.

This percent reduction will actually fall as soon as you gain a level if you're still wearing the same armor. You haven't lost anything, it's merely showing you that your armor isn't as effective against monsters one level higher than you used to be.

%Reduction = Armor / (Armor+400 + 85*Level)

...is the formula. I think the graph I made is a heck of a lot more useful to understand how it works:

(I'd like to get a local copy of this image. I am a member of the site to which I'm linking and author of the post of which this is an excerpt. -- Alastriona)